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WACC via CAPM:
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The Cost Of Capital Calculator Kroll uses the Capital Asset Pricing Model (CAPM) to estimate the cost of equity and weighted average cost of capital (WACC). It employs Kroll's method with equity risk premium for accurate cost of capital calculations, which is essential for investment decisions and corporate finance analysis.
The calculator uses the CAPM formula:
Where:
Explanation: The CAPM model calculates the expected return on equity by adding a risk premium (beta times equity risk premium) to the risk-free rate. Kroll's method provides refined estimates for the equity risk premium component.
Details: Accurate cost of capital calculation is crucial for investment appraisal, capital budgeting, corporate valuation, and strategic financial decision-making. It serves as the discount rate for future cash flows and helps determine the minimum acceptable return on investments.
Tips: Enter the risk-free rate as a percentage (typically based on government bond yields), beta coefficient (measure of stock volatility relative to the market), and equity risk premium (market risk premium). All values must be non-negative.
Q1: What is the risk-free rate typically based on?
A: The risk-free rate is usually based on long-term government bond yields, such as 10-year Treasury bonds for US-based calculations.
Q2: How is beta coefficient determined?
A: Beta is calculated by regressing a stock's returns against market returns. It measures the stock's sensitivity to market movements.
Q3: What makes Kroll's method different?
A: Kroll's method provides more refined estimates of equity risk premium by considering current market conditions, historical data, and forward-looking expectations.
Q4: When should WACC be used instead of cost of equity?
A: WACC should be used when evaluating projects or companies funded by both debt and equity, while cost of equity is appropriate for equity-financed projects.
Q5: Are there limitations to the CAPM model?
A: Yes, CAPM assumes efficient markets, single-period horizon, and that beta fully captures risk. It may not account for all risk factors in real-world scenarios.